Thursday, September 18, 2008

Student Loan Scandal for the Ages

by Daniel Bennett

Student loan companies, such as Nelnet, have been taking advantage of a loophole in a federal program, originating in 1980 during a time of high inflation and hence, high interest rates, that allows them to recycle accounts and continue to collect student loan subsidies at 9.5 percent interest. What a remarkable return, especially considering many of those same subsidized loans were most likely capped at 6.8 percent. In essence, the government is paying a 2.7 percent premium on a subsidy program, which is more than it pays to lenders of short-term treasury notes. How can I get a piece of that action?

Terry Heimes, President of Nelnet, realized several years ago that this was a loophole in the legislation and, I assume, an unethical business act. He did what any presumptuous capitalist seeking extraordinary compensation would do by continuing the practice of recycling account numbers and collecting overly-generous 9.5 percent subsidies at the expense of the taxpayer, under an archaic law that the government dropped the ball in altering.

Despite being aware that Nelnet was exploiting federal funds, it is not completely culpable. So who is to blame you may ask? Nelnet and other lenders repeatedly inquired with the Department of Education in 2002 as to whether the act was legal, to no avail. More than a year after Nelnet's request for a ruling on the issue, the DOE responded with a letter that quoted the three paragraph law, leaving it open to interpretation and failing to make a proper recommendation. This prompted the student lending community to continue with its fallacious act.

The DOE bureaucrats were apparently timid to put their neck on the line and risk their already excessively tenured positions. It was not until 2007 that the DOE even realized that the lending companies were making illegal subsidy claims, after the Inspector General's audit was released. Come on now, how much forewarning does one need...apparently 4 years before anyone decides to turn over the leaf and observe the maggots that lie beneath.

Representative Petri of Wisconsin spearheaded the part of the Higher Education Act in July that requires the Justice Department to review any approved settlement that costs the taxpayer more than $1 million, legislation aimed to debunk the student lending agencies. In other words, if a company claims subsidy payments at 9.5%, then they must pass an audit by the Justice Department, a procedure estimated to cost the company around $100,000, according to Phillip Van Horn, president of the Wyoming Student Loan Corporation. Mr. Van Horn professed that the cost of the audit would outweigh the benefits that the additional revenues at the 9.5% subsidy would provide, which may be the case or it may be an indirect admission of false play.

The real tragedy of this malicious activity is two-fold:

1) The Government took action to prevent this from happening in the future with the audit requirement, but it also turned an eye to the hundreds of millions of dollars already falsely collected by the lenders. There was recognition of wrong-doing, but no attempt to impose fines or recollect the money from the violators. High-five!

2) There is now less money to lend to college students, (we often forget about them) who rely on these loans to finance their education, because it evaporated into the pockets of the companies that knowingly took advantage of the situation.


Jon H. Oberg said...

The thrust of Mr. Bennett's commentary is correct: the 9.5 loan scheme was a costly scandal. The latest estimates put the cost to taxpayers at over a billion dollars. Several facts need to be added.

During the height of the lenders' 9.5 claims, students were paying variable interest rates that were at historic lows. Lenders claiming a guaranteed 9.5 percent return were actually gaining as much as a 6.6 percent premium.

There was no loophole in the legislation. The inspector general found no loophole and the Secretary of Education confirmed his report in January, 2007. The idea of a loophole was made up by the lenders.

Department of Education bureaucrats actually knew a great deal about the scheme as it was unfolding. Each attempt to kill it was thwarted by political appointees in the Department with ties to the student loan industry. It is indeed unfortunate that bureaucrats who knew of the scheme did not put their necks on the line to stop it. Not surprisingly, those who played along were handsomely rewarded. One official went around the system to alert Congress, but Congress itself took over two years to shut the scheme down.

Congressman Petri's amendment to the Higher Education act requires the Attorney General to review Department of Education settlements with lenders forgiving them for their illegal claims. To date, there has been no indication that either the Department of Education or the Department of Justice will comply.

Some of the illegal payments to lenders may have gone eventually to student aid, but only after much was siphoned off for lender executive compensation and, as documented in one state audit, serious partying.

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